It's never pleasant to eat a post-holiday plate of crow, and after the last year or so of economic miscalculation and sudden catch-up, officials at the Federal Reserve have had a platterful.
Neel Kashkari, CEO and president of the Federal Reserve Bank of Minneapolis did some chowing down in a public essay. It is titled Why We Missed On Inflation, and Implications for Monetary Policy Going Forward.
He noted that "many of us—those inside the Federal Reserve and the vast majority of outside forecasters—together made the same errors in, first, being surprised when inflation surged as much as it did and, second, assuming that inflation would fall quickly" and then asked the question, "Why did we miss it?"
The problem is long-held economic models that expect the primary drivers of inflation to be "(1) labor market effects via unemployment gaps, and (2) changes to long-run inflation expectations." That is to say, the so-called Phillips-curve model. Even if the institution had been able to anticipate all the shocks — pandemic, collapse of supply chains, missing workers, enormous federal stimulus, and the war in Ukraine — Kashkari thinks the prevalent model wouldn't "have come anywhere close to forecasting 7 percent inflation."
That leans to the latter part of his piece, on what this means for current monetary policy, which sounds like more of what has already been used. "I understand it will take some time to develop models that fully account for these different sources of inflation," he wrote. "Meanwhile, we still have a responsibility to bring inflation back down to our target."
Kashkari, who, remember, is only one official at the Fed, so this is far from cast in stone, thinks the entire process of bringing inflation back to 2% consists of three steps. The first was to rapidly increase rates, which happened during 2022.
In his eyes, that part isn't quite over. Even though "we are seeing increasing evidence" that inflation might have peaked, he suggests that there will need to be increased rate increases over the next few meetings. If literally a few, as in at least three, that would go through the meeting in early May at least, if not also into the mid-June one.
If then they believe inflation is on its way down, Kashkari sees a temporary pause. (His estimate is that the federal funds rate will be at 5.4% then, rather than the 4.25% to 4.5% range it currently is at.)
"Once we see the full effects of the tightened policy, we can then assess whether we need to go higher or simply remain at that peak level for longer," he writes. "To be clear, in this phase any sign of slow progress that keeps inflation elevated for longer will warrant, in my view, taking the policy rate potentially much higher."
This new year could feel pretty long.
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